By David Harby From Loeb Smith

In this Briefing Note, we aim to provide a brief overview of the principles governing derivative and multiple derivative actions in the Cayman Islands.

What is a derivative action?

A derivative action is one commenced by one or more minority shareholders on be- half of a company of which they are member in respect of loss or damage which that company has suffered. Such a claim can only be brought in certain circumstances and amounts to an exception to the rule that a company, as a separate legal person, should sue and be sued in its own name (often referred to as the rule in Foss v Harbottle (1843), 2 Hare 461; 67 E.R 189). The circumstances in which such a claim may be brought were set out by Jenkins, L.J., in Edwards v Halliwell [1950] 2 All E.R. 1064:

“It has been further pointed out that where what has been done amounts to what is generally called in these cases a fraud on the minority and the wrong- doers are themselves in control of the company, the rule [in Foss v Harbottle] is relaxed in favour of the aggrieved minority who are allowed to bring what is known as a minority shareholders’ action on behalf of themselves and all others. The reason for this is that, if they were denied that right, their grievance could never reach the court because the wrongdoers themselves, being in control, would not allow the company to sue.”

The true nature of a derivative claim is often misunderstood. In the leading case on such actions in the Cayman Islands, Renova Resources Private Equity Limited [2009] CILR 268, at p. 275, Foster, J cited the explanation of such actions offered by Professor Gower in Modern Company Law, 3rd ed. (1969), at 587:

“Where such an action is allowed, the member is not really suing on his own behalf nor on behalf of the members generally, but on behalf of the company itself. Although (…) he will have to frame his action as a representative one on behalf of himself and all the members other than the wrongdoers, this gives a misleading impression of what really occurs. The plaintiff shareholder is not acting as a representative of other shareholders, but as a representative of the company (…) In the United States (…) this type of action has been given the distinctive name of a “derivative action,” recognising that its true nature is that the individual sues on behalf of the company to enforce rights derived from it.”

How to commence a derivative claim

Derivative claims, as with the majority of actions commenced in the Cayman Islands, are normally begun by serving a writ and statement of claim on the relevant defend- ant or defendants. Grand Court Rules O.15, r.12A provides that where a defendant gives notice of an intention to defend the claim, then the plaintiff must apply to the Court for leave to continue the action. Such an application should be supported by affidavit evidence verifying the facts on which the claim and entitlement to sue on behalf of the company are based. The same must be issued within 21 days of the later of (a) the date of service of the statement of claim; or (b) the date when notice of an intention to defend was given. Further, the application, together with the affidavit evidence in support and any exhibits, must be served on the defendant or defendants not less than 10 clear days before the date for the hearing of the application (known as the return date). Where the plaintiff does not meet this deadline, the defendant may apply for the dismissal of the action.

The hearing of the application

Pursuant to Grand Court Rules O.15 r.12A(8) on the hearing of the application, the Court may grant leave to continue the action for such period and upon such terms as it thinks fit, dismiss the action, or adjourn the application and give such direction as to joinder of parties, the filing of further evidence, discovery, cross-examination of deponents and otherwise as it considers expedient.

In Renova Resources Private Equity Limited, Foster, J., affirmed the application in the Cayman Islands of the test to be applied in determining whether to grant leave to continue the action put forward by the English Court of Appeal in Prudential Assur. Co. Ltd v Newman Indus. Ltd (No. 2) [1981] Ch. 257. Foster, J., held that:

“(…)there are two elements to this: first the plaintiff [is] required to show pri- ma facie that there [is] a viable cause of action vested in the company and, secondly, that the alleged wrongdoers [have] control of the company (or could block any resolution of the company or the board) and thereby prevent the company bringing an action against themselves.”

The Judge further held that (at p. 283):

“For the plaintiff to obtain leave to continue with the action, I consider that I must be satisfied in the exercise of my discretion that its case is not spurious or unfounded, that it is a serious as opposed to a speculative case, that it is a case brought bona fide on reasonable grounds, on behalf of and in the interests of the company and that it is sufficiently strong to justify granting leave for the action to continue rather than dismissing it at this preliminary stage.”

Foster, J., ruled that in order to satisfy the Court in the above terms it was necessary for the plaintiff to do more than show the absence of the grounds required for a strike-out in the ordinary course of litigation. However, the Court should not look to hold a mini-trial of the issues. Instead the Court should form a view based on its first impressions, having regard to its assessment of all of the evidence before it, including any evidence submitted by the defendant.

The First and Fifth Defendants in Renova Resources Private Equity Limited had sought to argue based on the English authority Airey v Cordell [2007] Bus. L.R. that the Court needed to go further and consider whether a hypothetical independent board acting reasonably would have brought the claim and proceeded with the case. After considering the authorities in the area, Foster, J., concluded that such a question was only relevant where the shareholder in question sought an indemnity for his costs from the company on whose behalf action was being taken.

Multiple Derivative Action

In Renova Resources Private Equity Limited the Grand Court held that in appropriate circumstances multiple derivative actions would be permitted. In that case the plain- tiff had brought an action in respect of loss incurred by a wholly-owned subsidiary of the company in which it was a shareholder and therefore loss to the subsidiary caused indirect loss to its parent company and shareholders. However, the rule against recovery of reflective loss applied such that a shareholder or parent company would not be permitted to claim for indirect losses which mirrored those losses suffered directly by the relevant subsidiary or indeed sub-subsidiary on whose behalf action was being brought.

For more information relating to derivative claims and shareholder disputes, please contact:

David Harby

Head of Commercial Disputes and Litigation
E [email protected]
W www.loebsmith.com

SOURCE: http://www.loebsmith.com/story/2015/12/21/derivative-claims-in-the-cayman-islands/30/